How It Works

• Low-income people have to pay taxes like everybody else. Even if your income is so low that you don't owe any income tax, you still have to pay Social Security and Medicare taxes, which can take a significant bite out of an already small paycheck. To keep taxes from giving low-income people an incentive not to work, Congress created the EIC, also known as the Earned Income Tax Credit. The credit directly reduces the amount of money you owe in taxes -- and if your credit turns out to be larger than your entire income tax bill, the government sends you a refund for the difference. But it's available only to people who work; non-working people with other income streams aren't eligible, even if that money is taxed, as unemployment benefits are.
  
  

Income Levels

• If your income is below a federally determined level for your household size, you may be able to qualify for the EIC. For the 2010 tax year, for example, the maximum household income levels ranged from $13,460 for a single person with no children to $48,362 for a married couple with three or more children. These limits rise with inflation. When adding up your income to see whether you qualify for the EIC, you must include income from all sources -- earned and unearned. This includes unemployment compensation.
  
  

Earned Income

• As long as your total income is under the maximum, the more you earn, the bigger your EIC will be. As of 2010, the maximum credit ranged from $457 for a household with no children to $5,666 for a household with three or more children. But the size of your credit is based only on the portion of your income that is "earned," by the government's definition. Earned income is wages paid to you by an employer or money that you made from self-employment. It does not include unemployment benefits. In essence, then, the money you receive from unemployment may be enough to disqualify you from receiving the EIC, but it won't help you get a bigger EIC.
  
  

Other Unearned Income

• In addition to unemployment benefits, other income sources that you must include in total income but that don't qualify as "earned income" include interest, dividends, pensions and annuities, spousal- and child-support payments, welfare payments, workers' compensation benefits and veterans' benefits. If you have nontaxable military pay, such as combat pay or a military housing allowance, you don't have to include these in total income, either. However, you can choose to include combat pay if it will help you get a bigger EIC.